The economics and politics of instability, empire, and energy, with a focus on Latin America and the Caribbean, plus other random blather and my wonderful wonderful wife. And I’d like a cigar right now.

March 10, 2010

Dubai in debt

On November 25, 2009, Dubai World announced that it intended “to ask all providers of financing to Dubai World and Nakheel to ‘standstill’ and extend maturities until at least 30 May 2010.” The problem was Nakheel, the real estate arm that had (among other things) created the artificial Palm and World islands. Nakheel had $4.05 billion in debt coming due on December 14, and it couldn’t finance it. Stands to reason that Nakheel was overleveraged, right?

Well, not really. According to Nakheel’s June 2009 filing, it possessed $20.0 billion in liabilities against $40.0 billion in assets, which isn’t bad at all. Of those assets, $30.7 billion were “properties under construction.” Since Nakheel acquired land for free from the Emirate’s government, those costs were actual construction costs, and didn’t reflect overheated land values. Sounds good, very responsible. They could sell the properties for a full third less than they cost to construct and still be solvent.

The problem was cash flow. Sometimes nobody wants to buy gold-plated bidets at any price, whether at cost or ⅔ of cost or whatever. On a gross profit of $175 million for the first half of 2009, Nakheel took impairment costs of $3.3 billion. Now, that might be theoretical — but cash flow from operations was negative $948 million in the same filing. That is not good when you’ve got a lot of debt coming due and a world financial system in the midst of freezing up. In normal times, Nakheel might have been able to brazen through, even with the 50% decline in Dubai property prices between September 2008 and September 2009. This was not a normal time.

The IMF put together a handy time series on the cost of insuring debt from the government of Dubai and Nakheel. There are two interesting things and a mistake in the time series. First, it looks like the markets didn’t pay any attention to Moody’s. Second, they paid a lot of attention to Sheikh Mohammed bin Rashid Al Maktoum. (Strangely, the first turned out to be right and the second wrong.) Third, the $10 billion support package wasn’t really a support package from Abu Dhabi. Rather, the Emirate of Dubai sold $10 billion in bonds to the central bank of the UAE and used the revenues to backstop its public entity debt. The actual bailout didn’t come until December 14, when Abu Dhabi stepped in to lend Dubai World $10 billion to pay its sukkuk.

So where to from here? Well, there is a lot of debt coming due over the next few years. In millions of U.S. dollars:

Dubai Holding

Dubai World

ICD

2010-Q1

$ 600

$ 1,199

$ 3,250

2010-Q2

$ 2,933

$ 3,140

$ 294

2010-Q3

$ 0

$ 0

$ 0

2010-Q4

$ 295

$ 140

$ 920

2011-H1

$ 0

$ 4,455

$ 1,544

2011-H2

$ 3,161

$ 2,192

$ 6,044

2012-H1

$ 500

$ 0

$ 3,702

2012-H2

$ 330

$ 4,592

$ 2,191

2013-H1

$ 260

$ 1,000

$ 1,222

2013-H2

$ 246

$ 550

$ 2,640

2014-H1

$ 1,511

$ 0

$ 154

2014-H2

$ 632

$ 350

$ 1,957

Beyond 2014

$ 4,621

$ 4,534

$ 4,357

The Emirate of Dubai certainly can’t pay it. The government is in already in deficit. It will need to raise taxes to maintain basic services and pay the interest on the $18.7 billion that it currently owes — yes, the UAE central bank wanted interest, and lots of it. Raising taxes even further to support the development companies seems, well, not that likely.

Dubai could default, but that would pose a bigger problem. First, as readers of this blog certainly know by now, sovereign immunity basically doesn’t exist in the United States or European Union. Creditors could go after any and all Dubai-owned assets used for “commercial purposes.” Dubai has already started “ringfencing” its bad debts, for example by listing DP World on the London Stock Exchange as a separate entity, or transferring Nakheel’s overseas property holdings to Istithmar World. Those strategies, however, depend on laws in the U.S. and E.U., and so they have limits. (Judge Griesa would have a field day.) Second, Dubai depends on debt. An Argentine-style strategy would wreck Dubai’s entire development model.

Disclosed debt

Other liabilities

Total liabilities

Dubai World

$ 26,219

$ 7,866

$ 34,085

Dubai Holding

$ 15,090

$ 4,527

$ 19,617

ICD

$ 28,275

$ 5,655

$ 33,930

Dubai government

$ 18,700

$ 0

$ 18,700

Other Entities

$ 1,885

$ 0

$ 1,885

Total

$ 90,169

$ 18,048

$ 108,217

Total (ex-government)

$ 71,469

$ 18,048

$ 89,517

It’s a problem. But it isn’t necessarily a killer. First, Abu Dhabi knows that world markets will be rocked if Dubai entities start defaulting. Since Abu Dhabi has invested billions and billions in those very markets, it has an interest in making sure that Dubai debts are restructured in an orderly fashion. In fact, the Abu Dhabi government has stated that it will continue to “support Dubai in its efforts to achieve a viable position.” Second, of the $22 billion in Dubai debt that the IMF estimates has been affected by the standstill, $12 billion consists of syndicated loans and $7.5 billion of individual loans, with only $2.5 billion in bond issues. The prevalence of bank debt makes restructuring easier, since Dubai can assemble and talk to a small group of creditors. Finally, Dubai may have overbuilt, but there is still a reason for there to be a city there: it probably isn’t going to go the way of Detroit. With debt-to-asset ratios around 50% (pre-crash) the city-state’s public development entities will probably be able to find some combination of debt restructuring and price cuts that keeps them solvent.

California didn’t go away after 1873, Panama remained a great place for a canal after 1888, and Miami remains a very nice city in 2010, for some values of “nice” anyway. The go-go days may be gone, but I suspect that a major trading center will remain.

Then again, that trading center may be rather smaller than the current one. This will, finally, bring us to Mr. Cotter’s question in the next GCC post. Until then, any questions, criticisms, requests, or ideas?